Revenue recognition is a critical aspect of accounting, and the implementation of the Financial Accounting Standards Board (FASB)’s Accounting Standards Codification (ASC) 606 has changed revenue recognition for companies across all industries including home building.

The purpose of ASC 606 is to align the revenue recognition policies under GAAP to be when control of a good or service gets transferred to a customer. Home builders reporting under GAAP  have historically applied ASC 605 legacy revenue recognition guidance, as well as guidance in ASC 970, Real Estate – General, which addresses whether costs associated with acquisition, development, construction, sale or rental of real estate projects (other than real estate projects developed for an entity’s own use) should be capitalized or charged to expense as incurred. Specific guidance in ASC 970 was amended or eliminated by ASC 606, including the guidance to account for costs incurred to sell real estate. Based on the new standard, the application of ASC 606 may significantly affect a homebuilder’s revenue recognition criteria.

Applying ASC 606 to Home Building

Home building is a crucial sector of the economy, accounting for approximately 16.2% of GDP in 2022. Home builders operate in a highly regulated environment and must comply with various rules and regulations to ensure the safety and quality of their construction projects. Revenue recognition for home builders can be complex and may differ from company to company based on the specific nature of the organization and the contracts it enters into.

The most common application of ASC 606 that we have noted through working with homebuilder clients and our analysis of public information involves this five-step model for revenue recognition:

Step 1: Identify the Contract With the Customer

A contract is an agreement between two parties that creates enforceable rights and obligations. The standard defines a customer as “a party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration.” Home builders typically enter into contracts with their customers to construct and sell homes. The ASC 606 standard requires that home builders identify the contract with the customer and assess whether the agreement meets specific criteria, including whether it is probable that the homebuilder will collect payment for the goods or services provided.

Step 2: Identify the Performance Obligations in the Contract

A performance obligation is a promise to transfer a distinct good or service to the customer. For home builders, the performance obligation may simply be the sale of an individual home or residential unit; however, the homebuilder must consider whether other obligations, such as completion of common areas (which are generally transferred to third parties), may represent separate performance obligations (i.e., where the third party may be considered an extension of the customer). Home builders may also have contracts for the transfer of multiple homes to a specified party and may find themselves having multiple performance obligations for each development project. The ASC 606 standard requires that home builders identify all the distinct performance obligations in the contract and allocate the transaction price to each one based on its relative standalone selling price.